A Citizen's 2% Solution

How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget

The Big Lie of Government: the Myth of Progressive Taxes

“We have a system that increasingly taxes work and subsidizes non-work.”

-    Milton Friedman

If even Milton Friedman, one of the most ardent and influential free market economists, could see that, why hasn’t anyone in his profession or the political arena taken up the challenge of trying to redress that wrong? 

America’s tax revenue policies are grotesquely skewed in favor of the already rich.  Our vaunted Progressive Tax Policies are a Myth.  How do our leaders justify the intellectual dishonesty which allows public debate to be guided by the claim “nearly 50% of the public pays no taxes”?   The only way the myth is true, is if you close your eyes, hold your nose and pretend that employment taxes are not taxes. 

Today, inclusive of employment taxes, members of the “working middle class” bear the highest marginal tax burden on their wages and salaries, a rate which peaks at 40.3% for an individual with taxable earning of just $33,951, and drops sharply when earnings exceed $106,800. 

 

Yes, our government tries to distract us by pretending that employment taxes are somehow not “taxes” and by pretending that the employer portion of the assessment isn’t really a tax against the employee but upon the employer, but these are obvious semantic fictions.   If gross employer payroll represents the full value of services performed (and it obviously does), then whatever portion of that gross payroll is diverted to the federal coffers is a tax upon the employee’s wages. 

If one shifts attention away from earned income, i.e. wages and salaries, to investment income, tax rates drop still lower and policies are even more inequitable.  The privileged and lucky man or woman whose wealth is already so substantial that they do not need their income, can structure their investments to generate nothing but unrealized gains and avoid an annual tax bill altogether.  As shown in the example below, while an individual with $75,000 earned as wages or salary will pay tax of 33.4%, that same income earned on investments is taxed at rates from 40% to 100% lower. 

Did I hear you say you think the wealthy are over-taxed?  Until we stop lying to ourselves about the policies we currently have, we will never develop better options. 

Can anyone explain to me how/why the recent Simpson/Bowles’ and Rivlin/Domenici’ Tax Reform Commissions justify ignoring the issue of “inequity” inherent in federal revenue policies as they evaluate our fiscal options?  Once again, our leadership seeks to perpetuate preferences toward the wealthy while requiring sacrifice from the working middle class.  Are they willfully ignoring the facts of our current situation?  Or have they become victims of their own misrepresentations?  One recent insider assessment of the collapse of Merrill Lynch attributed its demise to having “fallen for our own scam”.  I posit that the financial gurus responsible for our tax policies have fallen into a similar trap; they have spent so much time semantically misrepresenting the nature of our tax policies that they have become unable to see the underlying truth and fallacy of what they have constructed. 

Let me re-frame the issue with a simple question: Do we really think the investment classes should be free from obligation to contribute to nearly one third of our government functions?  According to the CBO, 2010 budget outlays for social security and medicare were projected at $1.15 trillion, 32% of total projected outlays of $3.59 trillion.  But our tax policies assess the entire obligation for these important social programs upon low and middle income wages and salaries, exempting investment earnings and high wage earnings from assessment toward this obligation.  Worse yet, for roughly fifty years, while our historic social security “contributions” have exceeded social security outlays, instead of investing the surplus in tangible, productive assets our government has squandered those surpluses funding structural current deficits. 

The “Trust Fund” is empty.  It consists of a “soft promise” to provide future benefits which can only be funded from future tax revenues or borrowings.  This past year “employment tax” revenues exceeded income tax revenues and, being fungible as they are, they were intermingled as general receipts.  The “Trust” involved here is no more reliable than the promise Bernie Madoff gave his customers.

Now I’m sure Monique Morrissey of the Economic Policy Institute disagrees.  Supporting the legitimacy of the “Trust Fund” in a recent NPR discussion she described the situation between the Federal Government and its Citizens as similar to a parent and child and the “kid’s piggy bank” – suggesting it didn’t matter if the parents were living beyond their means so long as they had the ability to draw more on a credit card.  When the kid wants some of his money to buy a mountain bike they will simply draw on the credit card and buy the bike.  Her analogy is essentially correct.  Except spending social security contributions is not really like holding the average child’s paper route earnings while the youngster saves for a mountain bike.   It’s more like blowing a child star’s seven figure annual salary on cocaine, fast cars and trips to Vegas instead of investing in assets for his premature and extended retirement.  

The point she makes is not wrong.  The aggregate household (Treasury) situation doesn’t change regardless of whether there is or isn’t an IOU in the drawer saying Mom (Uncle Sam) owes Kid (John/Jane Q Public).  But exactly what that proves isn’t clear to me.  The Household (Treasury) either is or isn’t insolvent – and a bunch of pieces of paper in the Treasury that say effectively “I Owe Me” don’t make it any more solvent or provide any comfort or guarantee that the promises associated with those pieces of paper can or will be honored. 

If you ignore the semantic nonsense and simply evaluate the underlying facts it should be readily apparent that the only functional accomplishments of calling employment taxes “contributions” are a) it obscures the fact that the working middle class bears a higher marginal tax burden than their more affluent and successful neighbors and b) it shields those more affluent citizens from contributing to these important social programs.  The accumulation of “Trust” promissory notes in a drawer doesn’t change the fact that for fifty years social security contributions have been consumed by current government outlays and all future benefits will be funded with future taxes or increased borrowings.  We don’t have to wait until 2037 for the Trust to run dry; there are no real assets in it now.    

The current debate about the “Bush” tax cuts is a smokescreen which obscures a much deeper problem: a minor manipulation of marginal tax rates is not an adequate response to what Alan Greenspan recently described as a pending catastrophe.  We cannot tax cut our way to prosperity.  We cannot tinker this broken system to solvency.  Equitable and effective tax reform will require a structural rethinking of tax revenue policies. 

Neither the Simpson/Bowles’ nor the Rivlin/Domenici’ proposal address these critical problems.  Both Commissions address the challenge of social security by arguing we should start the process of breaking benefit promises without illuminating, or even acknowledging, the underlying inequity of how the contributions have been squandered to date.  Both plans will perpetuate and indeed exacerbate existing policy flaws. 

The critical first step in reforming our policies is to illuminate the deep, deep inequities that currently exist – and then evaluate how to correct them.  There are two questions we should be asking. 

  1. Is it right for us to continue taxing the middle class at higher rates than we tax the wealthy? 

  2. Is there a more effective tax structure we could use which would allow us to normalize tax rates between the working class and the investment class without stifling economic growth? 

For what it’s worth, I think the answers are respectively, and firmly, NO! and YES! 

Douglas Hopkins

Author – A Citizen’s 2% Solution:  How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6 www.2pctsolution.com

For a more specific and expanded response to the Simpson/Bowles proposal go here.

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3 Responses to “The Big Lie of Government: the Myth of Progressive Taxes”

  1. [...] The Big Lie of Government: the Myth of Progressive Taxes [...]

  2. [...] as argued more fully nearby, our progressive income tax policies are more illusion than fact.  See Myth of Progressive Taxes.  Progressive rate schedules apply to less than 25% of the overall federal/state/local tax [...]

  3. [...] in both plans, though different between them, arise from the failure to acknowledge or address the Myth of Progressive Taxes, defined and discussed nearby in a separate post.  In fact, both plans make existing policies [...]

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